 Let's talk plan 'b'. No, we're not referring to a rather good band from East London. We are instead referring to something that many good economists and writers in the blogosphere seem to have missed.
At the moment there seems to be two basic schools of thought, either Ben Bernanke and his merry Federal Reserve officials print the dollar into oblivion through hyperinflation (which isn't just high, super inflation, it's the complete collapse in confidence of the currency). Or we get a situation where no matter how much the Fed prints it can't cover the credit destruction, resulting in the bankruptcy of just about every corporation in the US and a collapse of the monetary system.
Since the Federal Reserve hinted at another dose of money printing back in August 2010, all commodity prices seem to be hell-bent on reaching the moon as quickly as possible. The idea of a collapse in the confidence of the monetary system doesn't look so far fetched these days.
But if the Fed does let the dollar go it will almost certainly mean the end of the road for the Fed and the many beneficiaries of the Federal Reserve system. An outcome that maybe be good for flushing out the malinvestments and liquidating the debt, but not so good for those close to the money printing machine.
But what if it doesn't work?
Now, remember Obama holds regular meetings of his National Security Council. Probably one of the highest level meeting that Obama oversees. Just who is sitting opposite each other at this small meeting? Secretary of the Treasury, Assistant to the President for Economic Policy and most notably The Chairman of the Joint Chiefs of Staff, a military guy, in this case Admiral Mike Mullen.
The interesting thing about Admiral Mike Mullen is what he considers the biggest threat to US National Security. It isn't 'terrorism' or 'cyber-attacks', it isn't even another country like Iran. In fact his biggest concern for the US is “the National Debt”. He clearly takes an interest in things economic, so if he considers the biggest national threat to be the Debt, one can safely guess he probably doesn't think to highly of printing a currency in to the abyss.
At these regular NSC meetings, is it not likely that someone like Admiral Mullen would ask Geithner (Treasury Secretary) and Summers (Assistant to the President for Economic Policy) a simple question. What if the money printing doesn't work, what if instead of getting economic growth and lower employment, all you get is runaway inflation and eventual destruction of the dollar – can Geithner give him a 100% guarantee that all the money printing will work? Anything less than a 100% guarantee will mean the next words out of any military planners mouth would be, “what's our plan 'b'”?
Sometimes it's all to easy to simply sit back and think that everyone in government is clueless (they certainly act that way a lot of the time). But there are people in government, especially with a military background, that like to work out different scenarios that might happen, and always have another plan to fall back on, 'just in case'.
It would be almost inconceivable, if behind closed doors someone around that table hasn't asked the question, “what do we do if it doesn't work?”. When you think about the response to this question, it's possible to piece together what the most likely reply would be.
History doesn't repeat itself, but it does rhyme – M. Twain
After the guns and butter of the 1960s the bills came due in the 1970s. The usual story of a government over promising, fighting wars and using borrowed money to pay for it. However, back in the 60s the US was still using gold to settle international trade. Some countries around the world decided to call America's bluff and rather than take paper dollars they wanted payment in gold – after all dollars were meant to be backed by gold, so this shouldn't be a problem. It quickly became a problem because the US had over-printed, and in August 15th 1971 the gold window slammed shut. Forcing the rest of the World onto a dollar paper standard. At the time there was no way of knowing whether this would possibly work. Looking back from today it's amazing that it did, essentially the US went from offering something tangible and real and has been money for over 5000 years, to offering pretty pieces of paper with green ink on them.
But at the time people couldn't be sure de-linking gold from the dollar would work. There was a real chance the rest of the World could reject the dollar, sound familiar? Can we see the workings of a plan 'b' back in the 70s that would preserve the monetary system of central bank issued currency (and by default the status quo) in a post dollar world?
In 1969, when rumblings about the US ability to honour its commitments in gold were starting to raise their head, the IMF was busy introducing a new unit of account, The Special Drawing Right (SDR). The IMF said the SDR would “increase international liquidity and help international trade”. It was also conveniently a good option to keep open should the dollar take a dive and a new global reserve currency was needed. It's easy to get bogged down on the technicalities of the SDR, but the simplest way to think of it is IMF printed currency divvied amongst IMF members (with more SDRs going to the larger contributors of the IMF club). This new currency can be used among members to settle international trade with each other.
By the 70's the SDR was valued against a basket of other major currencies (US Dollar, German Mark, French Frank, British Pound and the Japanese Yen). With the concern over the dollar coming off the gold standard the IMF issued its first allocation of printed SDRs (9.3bn). Whilst the value of the dollar declined in the 70's it was still accepted as the reserve currency by the rest of the world. However, moving into the 80's inflation looked like it could get out of hand and the stability of the dollar reserve was again under threat. Right on cue the IMF issued its second allotment of SDRs (this time 21.4bn) between 1979-81. A pattern seemed to be emerging at the IMF, whenever it looks like the dollar reserve standard might be under threat they ramp up their own SDR currency, just in case.
There was no appetite in the US to give up its privileged status of printing the World reserve currency. With Paul Volcker at the helm of the Fed and inflation peeking in 1981 at 13.5%, the Federal Funds Interest Rate was taken all the way to 20% the same year, stopping inflation dead in its tracks.
How times change, you have a Treasury Secretary who is 'quite open' to the idea of SDRs, and a Fed Chairman who can't even raise rates to 3%, let alone 20%, without bankrupting the US government and all its major banks should inflation start to get out of control. This time around it looks increasing likely that plan 'b' will be used.
Fast-Forward to Today
When the financial crisis hit at the end of 2009, at the depth of the fear and panic around the global economic stability, the G20 group of countries met in London. There was the usual jaw-boning about more oversight and regulation, and more capital for the banks. But buried away, and with little mainstream media comment, there was plan 'b' again. The IMF announced it would issue $250bn worth of SDRs to its members – only the 3rd allotment of new SDRs in the history of the IMF.
The change to accounting rules in the States and a massive dose of good 'ol fashioned liquidity seemed to arrest the fear of global meltdown, and talk of SDRs seemed to fizzle out. However, behind the scenes it's clear that the top central bankers were still working on an alternative to the dollar. In May 2010 there was a rushed high level conference in Switzerland on the International Monetary System, attended by the Worlds top Central Bankers. The press release from the IMF at the time read:
“Finally, in principle, a new global currency issued by a global central bank, with robust governance and institutional features... This global central bank [IMF] could also serve as a lender of last resort”
“... to seek a more prominent role for the IMF’s Special Drawing Right (SDR). With a value determined in terms of a basket... In addition, issuance by governments of SDR-denominated bonds or activation of a substitution account could promote the use of the SDR basket”
“A number of steps can be taken to strengthen the IMS, including... an enhanced role for the SDR”
Clearly, whilst Central Bankers of the world were telling the public about supposed 'green-shoots', the banking elites were busy putting their finishing touches to plan 'b'.
For some the SDR seems the panacea that can cure all ills, or at least smooth out those international monetary imbalances. But it's easy to get blind sighted and confused by the 'economic' jargon surrounding the SDR. What is being slowly proposed is the idea of a supra-central bank, with the ability to print it's own currency, and offer loans, all this without any ties to national countries and largely operating outside and representation by any citizens.
So What Does This Mean For Gold Prices?
One question remained, in order to give the fig-leaf of credibility would gold be part of the basket comprising the SDR? The FT screamed the answer this Monday on its front page, “Zoelick Seeks Gold Standard Debate”. Robert Zoelick, the Head of the Washington Based World Bank calls for a system that “needs to involve the dollar, the Euro, the Yen, the Pound and the Renminbi”. This sounds and awful lot like the basket of currencies the SDRs are comprised of that the IMF has been touting as the new global reserve.
Where Zoelick surprised was that he went onto add “the system should also consider employing gold as an international reference point. So what does this mean for the price of gold? let's be clear what is now being openly discussed, not by some 'fringe' websites, but by the head of the World Bank – a new global reserve currency with gold backing. Let me say that again, a new global reserve currency with gold backing. so how high can gold go? According to 2008 estimates from the McKinsey Global Institute, the price of gold would have to rally 47 times to officially remonetise, you do the math.
The Timing of Zoelick is impeccable, this week sees the G20 meet once again (11th-12th November), sure there will be the usual talk about 'working together', 'leadership' and 'improved supervision' – but keep your eyes open around any talk of SDRs, gold and plan 'b', tucked away within the communiqué.
Tom Paterson
Chief Economist
Tom is the Chief Economist at Gold Made Simple, one of the worlds leading gold bullion ownership and trading services. Tom previously worked as a Broker on a Futures and Options desk at a main brokerage in Canary Wharf and was responsible for the production of “The Economissed” , a research paper tracking Macro themes and trade ideas.
Tom is a keen student of the Austrian School of Economics – or as he refers to it 'real' economics – and feels very passionate about the lessons that can be gained by all that understand its guiding principals.
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